The Troubling Decline of American Business Dynamism

Tyler Cowen calls it the “great stagnation.” Former Treasury Secretary Larry Summers has proclaimed that the United States has entered a period of “secular stagnation.” Whatever its name, a growing number of researchers and economists are concerned that the U.S. is a less economically innovative country than it was even a decade ago.

A new Brookings study by Ian Hathaway and Robert Litan released today provides empirical evidence of America’s declining business dynamism over the past decade, and especially since the economic crisis and recovery. It builds on their earlier research, which I covered back in May, that found the U.S. economy to be less dynamic across all major industries, as well as across geographic regions. The new study uses data from the Census Bureau’s Business Dynamics Statistics dating back to 1977 to measure the flows of businesses and employees across sectors, regions and firm sizes.

There are two big takeaways here. First, the rate of new firms entering the U.S. economy has declined substantially over the past two decades. And second, younger businesses have also fallen off considerably, driven by the dearth of new firm formations.

The chart below, from the study, shows the rate of new firms entering and exiting the economy between 1978 and 2011—key markers of economic dynamism. The rate of firm death has been more or less constant, increasing slightly since the Great Recession. But the rate at which new firms are being created and entering the economy has trended slightly downward over the entire period.

Brookings Institution

The study finds that business failure rates (or exits) for firms of all ages have increased steadily since the Great Recession, with one exception: firms 16 years or older. The trend for those firms, the researchers find, is essentially flat. Furthermore, the failure rates for year-old firms have increased since the early 1990s, from 16 percent to 27 percent.

“Whatever the cause,” they conclude, “it appears to have become increasingly advantageous to be an incumbent, particularly a mature one, and increasingly disadvantageous to be a new entrant in the American economy.”

The chart below, also from the study, shows the leveling off in the share of young businesses and the rise of older businesses that have been around 16 years or more.

Brookings Institution

The study notes the pervasiveness of this trend, which is “occurring in every U.S. state and nearly every metropolitan area, across all firm size categories and broad industrial segments, even in high tech.”

Hathaway and Litan were unable to find strong evidence that the increase in business consolidation has contributed substantially to the aging of American businesses, in part because the trend has occurred across all firm sizes.

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These findings are supported by another study, released in June, by University of Maryland and U.S. Census Bureau researchers Ryan Decker, John Haltiwander, Ron S. Jarmin, and Javier Miranda. Using the Census Bureau’s Longitudinal Business Database (LBD), these researchers also find that firm exits are outpacing entries. Additionally, they discover that all sectors are suffering through a similar malaise.

The graph below tracks the share of employment contributed by young firms—those five years old or less—from 1982 to 2010 across a range of industries. While controlling for other factors like compositional shifts across industry and broad shifts in economic activity, the researchers also found that the share of Americans employed by young firms is declining, even in “hot” industries like tech (included in the “Information” category below). Notice that the lines on the graph slope down, indicating declining dynamism.

University of Maryland, U.S. Census Bureau

As they note: “The share of employment young firms in the U.S. economy declined from an average of 18.9 percent in the late 1980s to an average of 13.4 percent at the peak before the Great Recession, a 29 percent decline over 17 year period. Similarly, their contribution to the share of firms and job creation declined by 17 percent and 14 percent, respectively, from a high in the late 1980s of 46.6 percent and 38.7 percent, respectively.”

The researchers found that the decline in young firms has played a major role in the general decline in U.S. business dynamism. “The shifting age composition”— or the decrease in young firms—“accounts for 32 percent of the observed decline in job creation, 20 percent of the decline in job destruction and 26 percent of the decline in job allocation,” they write. “The change in the firm age composition is by far the most important of any of the individual factors we examine in accounting for the overall declines.”

The researchers further probed the kinds of entrepreneurial firms that have declined, making the important distinction between Mom and Pop businesses, or so-called “subsistence entrepreneurs”, and “transformational entrepreneurs” of the sort that create new technology and drive growth. Here they found the decline in subsistence entrepreneurs plays an important role in the broader decline in business dynamism. They note that this is especially severe in the rapidly growing retail and service sectors of economy, where Mom and Pop stores have increasingly given way to big boxes like Walmart and Target. But this reduction in subsistence entrepreneurs, they found, is not solely responsible for decreases in business dynamism. Indeed, when it comes to the more transformational high tech sectors of the economy, they found an increase in dynamism up to around 2000 and a sharp decline since then. They conclude that high-growth, high-tech transformation enterprises have seen substantial declines since 2000.

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A third study supports the Brookings finding that older firms are doing better, business-wise, than their younger counterparts. The study in the Bureau of Labor Statistics’ Monthly Labor Review used 2012 data to determine that the number of high-growth firms in the U.S. economy has fallen in recent years. The ratio of high-growth firms as a percent of total firms most recently peaked in the 2003 to 2006 period, at 2.7 percent. In 2008-2011, however, that number dropped to 1.5 percent, though it rebounded slightly during the recovery.

Monthly Labor Review

The Bureau of Labor Statistics economists found that while young firms are an important part of U.S. economic growth, the nation’s high-growth firms ages ten or older are doubly as important. Brand new high-growth firms are 14 percent of all high-growth firms—but high-growth firms ten and older are fully one-third, or 34 percent.

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The overall pattern here is troubling, though it may be too early to tell if business dynamism is down for good. There are generally long lags between the onset of crises and the rebounds in innovation and entrepreneurial activity that power long-run growth. These Great Resets are generational events, with much longer timelines than typical business cycles. Economic historians like Joel Mokyr and Alexander Field have argued that innovation is actually on the rise. “Technology has not finished its work; it has barely started," Mokyr toldPBS Newshour last year. In fact, studies of great economic crises find that innovations and waves of entrepreneurship fall off dramatically, only to be propelled by recovery in their wake.

It’s clear that Americans—and especially younger Americans—are still drawn to innovation and entrepreneurship. More than half of U.S. millennials want to start a business or have already started one, according to a 2011 poll. And yet the evidence of a real decline in business dynamism keeps stacking up. Call it whatever kind of "stagnation" you like—it's a problem that continues to plague America's "boring" economy.

About the Author

Richard Florida is a co-founder and editor at large of CityLab and a senior editor at The Atlantic. He is a University Professor and Director of Cities at the University of Toronto’s Martin Prosperity Institute, and a Distinguished Fellow at New York University’s Schack Institute of Real Estate.